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Vanna-Volga Methods Applied To Fx Derivatives: From Theory To Market Practice

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  • FRÉDÉRIC BOSSENS

    ()
    (Termeulenstraat 86A, Sint-Genesius-Rode, B-1640, Belgium)

  • GRÉGORY RAYÉE

    ()
    (Solvay Brussels School of Economics and Management, Université Libre de Bruxelles, Avenue FD Roosevelt 50, CP 165, Brussels 1050, Belgium)

  • NIKOS S. SKANTZOS

    ()
    (Ijzerenmolenstraat 113, Leuven B-3001, Belgium)

  • GRISELDA DEELSTRA

    ()
    (Department of Mathematics, Université Libre de Bruxelles, Boulevard du Triomphe, CP 210, Brussels 1050, Belgium)

Abstract

We study Vanna-Volga methods which are used to price first generation exotic options in the Foreign Exchange market. They are based on a rescaling of the correction to the Black–Scholes price through the so-called "probability of survival" and the "expected first exit time". Since the methods rely heavily on the appropriate treatment of market data we also provide a summary of the relevant conventions. We offer a justification of the core technique for the case of vanilla options and show how to adapt it to the pricing of exotic options. Our results are compared to a large collection of indicative market prices and to more sophisticated models. Finally we propose a simple calibration method based on one-touch prices that allows the Vanna-Volga results to be in line with our pool of market data.

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Bibliographic Info

Article provided by World Scientific Publishing Co. Pte. Ltd. in its journal International Journal of Theoretical and Applied Finance.

Volume (Year): 13 (2010)
Issue (Month): 08 ()
Pages: 1293-1324

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Handle: RePEc:wsi:ijtafx:v:13:y:2010:i:08:p:1293-1324

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Keywords: Vanna-Volga; Foreign Exchange; exotic options; market conventions;

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Cited by:
  1. Griselda Deelstra & Gr\'egory Ray\'ee, 2012. "Local Volatility Pricing Models for Long-dated FX Derivatives," Papers 1204.0633, arXiv.org.

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